There you go. Givin’ a #^@* when it ain’t your turn to give a #^@*. – Bunk to McNulty – The Wire
Over the past few months here at Risk Reversal we’ve been trying to translate what’s been happening over in Europe into some simple terms both for our own trading purposes and for our readers. We don’t pretend to be Macro experts by any means, and are simply armed with our undergraduate Economics and Political Science majors (lol) and some good explanations from great bloggers and writers who know way more than us about these things. It became clear to us pretty early on that what we were witnessing was a protracted negotiation happening within the Eurozone between the core countries like Germany and France, their banking sectors and the peripheral countries who were facing sovereign debt issues. This negotiation has played out in some predictable fashion as every time it seemed like at least a partial solution was at hand, one of the players in the game would suddenly change the rules of the game in order to better their hand. It’s been painful to watch to say the least.
During this time it also became obvious that the powers that be in the U.S. were growing increasingly frustrated watching this nonsense from afar. I joked on Quick Hits a few weeks ago that if I was President Obama, Fed Chair Bernanke, and Treasury Secretary Geithner I would have set up a tent outside the ECB and started a drum circle until the ECB finally came to their senses. #OccupyECB. As Dan said to me many times before, these guys must be looking at Europe and be thinking to themselves, “C’mon guys, we have the playbook from ’08, feel free to copy our notes.” This morning’s ‘Coordinated Action’ is kind of funny when you think about these things, because it really wasn’t coordinated at all. It was the U.S. getting sick of waiting. The economic data out of the U.S. along with a pretty good earnings season showed that Europe really is the thing holding back the economy from a more robust recovery. Here’s a great take on what happened this morning from Steve Goldstein at Marketwatch:
On one level, it’s almost funny to call offering dollars at a cheaper rate to foreign banks “coordinated” action.
It’s only coordinated in the sense that the Federal Reserve is printing the dollars and the European Central Bank and other central banks put the greenbacks in the virtual vaults of mangled commercial banks that are drowning in European debt. See story on Fed action.
But it’s not coordinated in the sense that the ECB taking any bold action of its own to stem the euro-zone debt crisis.
The ECB on Tuesday accidentally wandered into quantitative easing, basically when banks didn’t want to commit to lending money to the Frankfurt-based central bank, which effectively meant that a tiny sliver of the purchases of Spanish and Italian debt it made were funded from money printed out of thin air. See full story on Spanish and Italian debt.
That money printing, called quantitative easing, is old hat at the Fed, as well as at the Bank of England and the Bank of Japan. The results are admittedly debatable, but in ECB circles it’s unthinkable to contemplate, as the ghost of the Weimar Republic continues to haunt German policy makers.
Mario Draghi’s paltry quarter-point rate cut in his first month as ECB president was considered bold, and its main interest rate of 1.25% is still a full percentage point over the Fed’s, at a time when euro-zone banks are struggling for survival, as U.S. money-market funds have stopped funding them and as banks are too fearful to lend to each other.
Tuesday’s incomplete ECB draining operation also is evidence of the strains, since banks opted to hoard cash rather than get a week’s worth of low-risk interest.
So that’s why the Fed and pals stepped in, but it doesn’t make the problem of euro-zone debt go away. Only the ECB, Germany or France has the capacity to deal a decisive blow to euro-zone turmoil, and so far they have preferred actions that are chaotic and conflicting to those that are truly coordinated.
That pretty much sums it up. And who knows how the ECB reacts to this move. Dan and I have been very pessimistic and largely short single stock names through Puts, Spreads or Flys, especially banks over the past few months. We cut most of our shorts and even added a few longs in beaten down banks last week as we sensed something was coming to a head. What got us into that mode was that horrible German bond auction last week. The thinking being that the Germans could no longer sit around and wait, as this crisis was now striking them at their core. The odd thing is they still really haven’t stepped up to the plate, and the U.S. Fed was forced to react a week later.
So what’s next? We have no idea, and we can’t imagine that these fits and starts are done with. As mentioned in the Marketwatch piece “the ghost of the Weimar Republic continues to haunt German policy makers.” If you continue to read headlines out of Europe that portrays this crisis as some sort of economic morality tale between the thrifty Northern Europeans and the profligate Southerners, be afraid. If the headlines turn into more of a Kumbaya we’re all in this together, then maybe we’re about to see these guys get their act together. Here’s Nomura’s comments via FT:
Nomura takes a different view and we are all saved.
It’s always darkest before dawn and today’s coordinated move by central banks harks back to the crisis-fighting days of late 08. We are encouraged that the monetary authorities are indeed back on the case again working as a team. Global banks are obviously interconnected and thus given the USD funding tensions of late this global CB coordination is a sign that folks in the right places are “getting it.”
Alternatively, they are scared witless by the inaction in Europe and decided to do something. But we digress.
By no means does this address all of the issues facing markets (and we remain worried EU policymakers drop the ball) but it removes one roadblock and signals that perhaps more help is on the way. It is also, from a very high level stand point, a vote of confidence by the Fed that they view a euro breakup risk as low because an sort of increase in the FX line usage will result in more Fed exposure to Europe.
We think more positive surprises could be on the way in the form of more easing in the weeks/months ahead by all authorities (our economists see QE happening for G4 soon). Net, next 6 weeks of forced realignment by monetary authorities and eventual fiscal players will set the tone for price action for next 6 months. Reminder, let’s not forget the massive spread compression that happened post 08 into mid-09 which created a night/day experience for investor sentiment.